September 1, 2017

Good Morning! In this a.m.’s Blog, we consider the ongoing turn-back of fiscal authority from the State of Michigan to the City of Detroit, the fast-approaching Mayoral election in the Motor City, the searing fiscal challenge in Connecticut not to be Illinois, and the fiscal and physical challenges in Puerto Rico where Hurricane Irma and the PROMESA Oversight Board are bearing down.  

Visit the project blog: The Municipal Sustainability Project 

Post-Kilpatrick Motor City. The Michigan Tax Commission has relinquished its control over property reappraisals in Detroit, having voted unanimously to relinquish the state oversight Detroit has been under since 2014 in the wake of mismanagement in Detroit’s Assessment Division, widespread over-assessments, and signal property tax delinquencies—delinquencies in response to which the state commission had imposed a corrective action plan aimed at revamping how the city set its property taxes, or, as Alvin Horhn, Detroit’s assessor and deputy CFO noted: “This is one more symbol that city government has gotten this right: Detroit basically had been an island to ourselves for a long time. That type of intervention was hard to swallow.” The Commission’s actions came as a federal judge yesterday ordered the city’s former Mayor Kwame Kilpatrick to pay more than $1.5 million to the city’s water department as restitution from the City Hall corruption scandal—money which the city is most unlikely to collect, as Mr. Kilpatrick recently claimed he has less than one dollar in his prison bank account, where his longer than Mayoral term will run to 2037. Nevertheless, the judicial order would seem to bring to a close one of the remaining issues stemming from the landmark trial which ended with the former Mayor who bears such responsibility for plunging the city into the largest municipal bankruptcy in American history: he was convicted of running a criminal enterprise out of City Hall that included steering rigged water and sewer contracts to buddy Bobby Ferguson. The reduction in the fee came in the wake of a rule by the 6th Circuit U.S. Court of Appeals after it tossed the $4.5 million figure and directed U.S. District Judge Edmunds to recalculate the restitution amount. (Judge Edmunds had noted that the corruption indictment, which alleged that the cty’s former Mayor former Detroit Water & Sewerage Department Director Victor Mercado rigged bids and steered work to Lakeshore, which had hired Mr. Ferguson’s company as a subcontractor.) The order came in response to the former Mayor’s request that his conviction for racketeering and 28-year sentence be set aside—claiming there had been no corruption during his scandal-plagued tenure, a request he made some 13 months after the U.S. Supreme Court rejected his appeal.

The state Tax Commission’s action came in the wake of allegations that Detroit had been over assessing homes by an average of 65 percent, e.g. assessments imposing significant property tax hikes, based on an analysis of more than 4,000 appeal decisions by a Michigan tax board which has been overseeing a key part of the agreement from the citywide reappraisal initiated in 2014 to bring the Motor City’s assessment role into compliance with the Michigan General Property Tax Act to ensure all assessments are at one half of the market value and like properties are uniformly assessed—a reassessment the Deputy CFO noted had not been made in more than half a century. Michigan Tax Commission Executive Director Heather S. Frick noted: “The city has continued to move forward in their work to improve the residential reappraisal and to complete work on the commercial and industrial reappraisals to maintain and improve the residential reassessments.” The state commission granted Detroit an additional year to complete reassessment of commercial and industrial reappraisals. The good news for the city is that Michigan Tax Commission Chairman Doug Roberts noted that the work Detroit has done in its reappraisals has been “very positive.” He said he had been “concerned about it for a while, but I was very pleased with the report that we got yesterday: The fact of the matter is I think they have been working very hard on it. I was pleased to vote for it.” The city anticipates spending nearly $9 million on the reappraisal project, which has included use of aerial photography, mapping programs, and exterior inspections by staffers to gauge neighborhood conditions and better reflect property values—an effort Mayor Duggan had initiated at the beginning of this election year in the city when he presented his proposed 2017 property assessments in the wake of the completion of the parcel-by-parcel reappraisal for nearly 255,000 residential properties—a comprehensive reassessment which estimated 140,000 homeowners would realize reductions averaging several hundred dollars.

Getting Ready to Rumble. Post-chapter 9 Detroit is heating up with a key pre-election Mayoral debate scheduled for October 25th, when Mayor Mike Duggan will take on his challenger, Michigan state Sen. Coleman Young II. The candidates are to present their respective visions and strategies for the future of post-municipal bankruptcy Detroit, with this marking the second debate of the campaign, after Mayor Duggan prevailed in last month’s primary by a 67%‒26% margin, far higher than any of the remaining six contenders. A key emerging issue in the campaign appears to be what the city will do to address neighborhood recovery, with apprehensions that a newly gleaming and lively downtown has come at the expense of outlying neighborhoods, leaving out citizens who live within the city limits but outside of downtown and Midtown.

UnIllinois. Connecticut Gov. Patrick Malloy, the state’s 88th Governor, in a meeting with the editorial board of the Hartford Courant said that the state’s cities and towns need to tighten their belts, because the state can no longer afford to keep sending them millions of dollars every year, as he expressed pessimism about the state budget. The Governor noted he opposes any increase in the state income tax, even as he reported he sees no light at the end of the tunnel after the months’ long stalemate with the legislature:  “I don’t see that the House is anywhere near passing a budget that I could sign: Certainly everything I know about the budget that they’ve deliberated on over the past couple of weeks—means I would not sign that budget.” Gov. Malloy added: “Whatever the House passes, in line with what they’re talking about, wouldn’t get through the Senate. So, we really have made almost no progress…It’s clear to me that they’re not dealing with the budgetary reality. I think, quite frankly, they’re grasping for straws in an attempt to cobble together a budget.” He added that, unlike his predecessor, former Gov. Jodi Rell, he would not allow the state budget to become law without his signature.  Indeed, in response to the query whether the stalemate could last into December, his budget director, Ben Barnes, responded: “We can operate with all of the schools open and everything moving along until March.”

The budget stalemate comes as millions of state dollars are being withheld under an executive order, thus Gov. Malloy and his Budget Director Benjamin Barnes note that municipalities such as Hartford, Waterbury, Scotland, Sprague, and West Haven could be facing financial problems later in the fiscal year. Director Barnes noted: “We don’t want to have towns become insolvent or bounce paychecks or miss vendor payments…On the other hand, if they’re going to ask us for extraordinary help, we’re going to get in their business a little bit and make sure that they’re doing the things that they should be doing to get through a very austere and uncertain time.” At the same time, in this intergovernmental unbalancing act, Gov. Malloy has spoken strongly against any increase in the state income tax, saying it would be damaging to the economy and prompt some rich residents to flee the state.

Even though an income tax increase is not currently in any of the fiscal plans circulating at the state Capitol, some lawmakers have not backed off the idea. In an interview with an editorial board, the Governor noted: “A further raise in the income tax would be extremely detrimental to the long-term health of the state…Extremely detrimental…We should put up a one-way toll for everyone who moves to Westchester County.” The state raised the income tax rate on the state’s millionaires in 2009, 2011, and 2015; today the top rate is 6.99%; income-tax proponents have said they have at least 45 votes in the House Democratic caucus for an increase in taxes on the wealthy; however, House Speaker Joe Aresimowicz (Berlin) said earlier this year that 45 votes is far short of the requisite 76 votes to pass in the 151-member chamber. Similarly, Senate President Pro Tem Martin Looney (D-New Haven) notes: “There’s no serious proposal at this point out there on income-tax change.” He expects a vote on the two-year, $40 billion budget the week after next, noting: “There’s a growing sense that we need to vote that week to forestall the Governor’s executive order from taking effect…the Democrats will need to have an agreement with the Governor in order for the lieutenant governor to cast the tie-breaking vote.” House Majority Leader Matt Ritter (D-Hartford) agreed that the legislature must avoid large cuts to cities and towns that would take effect on the first of next month if Gov. Malloy’s executive order continues. Unsurprisingly, in his discussion with the Courant editorial board, the Governor was pessimistic about the long-running soap opera at the Capitol, noting that if the income tax were to become a major part of the discussion, the battle could last even longer: “I don’t think that there is any likelihood” of a budget passing with an income tax increase.” The Connecticut House is scheduled to vote a week fvrom next Thursday; however, the specifics have yet to be settled. In the state Senate, three moderate Democrats have all raised concerns about possible tax increases: there positions are critical as that chamber is evenly divided with 18 Democrats and 18 Republicans.

The legislative stalemate led some 25 mayors and first selectmen to travel to the Capitol this week to plead their case for increased assistance and a quick budget resolution: the municipal leaders are seeking to avoid a revised plan by the Governor which would eliminate all education cost-sharing funds for 85 towns and reduce the total for about 54 others: under the pending proposal, the towns would collectively lose hundreds of millions of dollars if the legislature is unable to pass a budget and the Governor’s revised executive order takes effect.

The proposed sales and use tax increase to 6.85 percent in the House appears to be the key impediment: Rep. Danny Rovero, a key swing voter in the House Democratic caucus, who represents the municipalities of Killingly, Putnam, Thompson, said he will vote against the pending budget due to the proposed hike in the sales tax to 6.85 percent, up from the current 6.35 percent: “I’m not in favor of the sales tax; I’m not in favor of any tax. I’m not saying it won’t pass, but it won’t be with my vote.”

Because the Democrats hold a 79-72 edge in the House, they can only afford the loss of three of their members; ergo, Rep. Rovero’s vote matters. Being one of the most fiscally conservative Democrats, Rep. Rovero’s position is that the legislature needs to cut state spending and shift more work to nonprofit organizations which hold contracts to provide state services, such as group homes. He believes that nonprofits provide the services at a lower cost than the state, where employees receive more generous benefits and larger pensions. Nevertheless, he appears willing to listen to the plan by Gov. Malloy and the House Democrats to raise the cigarette tax to $4.35 per pack, up from the current $3.90 per pack.

The looming vote comes as the Malloy administration has warned the towns repeatedly that they would be receiving fewer state funds than in the past. His budget spokesperson, Chris McClure, notes: “While we can disagree on our opinions, we should not disagree on the facts…And the fact is, over the last five years, municipal aid increased 21 percent as billions of dollars have been slashed elsewhere in the state budget.” For Gov. Malloy, he made clear, succinctly: “I’m trying to stop us from being Illinois.”

Physical & Fiscal Threats. As Hurricane Irma bears down on the U.S. Territory of Puerto Rico, a parallel fiscal storm is arising, as Governor Ricardo Rosselló has reiterated his refusal to give way to that guideline of the PROMESA Oversight Board: stating there will be public employment as usual, refusing to kowtow to the Board’s demand and clarifying that his actions are not a matter of imprudence, but rather of being “firm,” since, in his view, the Board’s order was not justified and was not contained in the fiscal plan, approved last March: “The implementation of the reduction of working hours was never an agreement within the fiscal plan. It was a recommendation that was implemented unilaterally,” noting his apprehensions that “such action is not necessary” since it exceeded the Board’s claims regarding a reservation, and noting that reducing the day would have “a negative impact on the economy,” as well as not be transformative of the government—stating: “There is a big difference between being firm and reckless. Our government is being firm in its position. There is no need for a reduction in working time now. There is not…But we want to be cautious and talk about how we got to that point. We must be cautious and give space to what would be the first reporting period that would be in October where our government has not yet had the opportunity to prove those findings under the PROMESA law. We are being cautious in this assertion. We are being rational in this assertion, but we are also being firm, because we understand that it is a measure that will not yield beneficial results for Puerto Rico and, therefore, tomorrow as we have established, that measure will not be implemented.”

The Governor’s comments came in reaction to the Board’s action early in the week to go to court Monday to force the government to comply with fiscal measures it deems necessary needed to revive Puerto Rico’s economy, seeking declaratory and injunctive relief against Gov. Ricardo Rosselló and his government, and a court order to mandate Puerto Rico’s government to introduce a 10 percent furlough program for most of its employees to save money. It is also asking the court for an order forcing the territory to comply with planned cuts to government pension benefits.  Natalie Jaresko, the executive director of the Oversight Board, said the measures are necessary to reduce spending: “Fiscal reform is a difficult but necessary process for Puerto Rico and the credibility of the plan lies in its enforcement.”

Nevertheless, the Governor stressed the importance of the ongoing dialogue with the PROMESA Board federal entity in charge of the island’s finances continues: “That goal and that commitment continues and I can tell you the day, still, although it does not appear at times, our government practically every day is in communication with the Board, with the Board advisers to continue measuring and looking for what are these targets for compliance with the tax plan: Let there be no doubt that our government has a commitment to comply with the fiscal plan.”

PROMESA Board Chair José Carrión said that the Governor is a citizen of “law and order” and expected him to comply with a possible reduction decision, adding that that the measure would be more severe if it was not done now.

What about the Municipios? The Puerto Rico Senate met yesterday in Mayagüez, Puerto Rico’s eighth-largest municipality, a muncipio founded as Nuestra Señora de la Candelaria, which is also known as La Sultana del Oeste (The Sultaness of the West), Ciudad de las Aguas Puras (City of Pure Waters), or Ciudad del Mangó (City of the Mango). On April 6, 1894, the Spanish crown gave it the formal title of Excelente Ciudad de Mayagüez (Excellent City of Mayaquez) to address the concerns of that area of ​​the country, especially the role of two regional airports in the economic development of the area and the precarious fiscal situation of the 12 municipalities of the area: the public hearing included members of the Senate, constituting what is known as a Special Special Commission. At the hearing, the mayors of the western area reviewed the main challenges facing municipalities in the midst of the economic crisis: among them, the recurrent theme of cuts in so-called subsidies for municipalities, some $ 350 million in two years. West Chamber of Commerce President Kenneth Leonor told El Nuevo Dia that the region’s economic problems could be tackled by public-private alliances in areas such as technology and tourism and municipal enterprises, noting: “We need more foreign and foreign investment that can reach Puerto Rico.” For Felipe Morales Nieves, president of the Economic Movement of Development of the West, it is crucial that improvements be made to the airport Rafael Hernandez, in Aguadilla, to turn it into an international one that serves the Caribbean clientele.

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What Could Be A Constructive State Role in Municipal Fiscal Stress?

August 25, 2017

Good Morning! In this a.m.’s Blog, we consider Virginia’s innovative thinking with regard to a state role in measuring municipal fiscal distress. Then we consider the changes in Detroit’s demographic conditions—changes which might augur further fiscal challenges on the Motor City’s road to recovery from the nation’s largest ever chapter 9 bankruptcy, before, finally, turning to Puerto Rico, where the legislature has just adjourned.

Visit the project blog: The Municipal Sustainability Project 

Municipal Fiscal Distress: What Is a State Role? Martha S. Mavredes, Virginia’s Auditor of Public Accounts, warned the legislature’s new Joint Subcommittee on Local Government Fiscal Stress, a committee created last June in the 2017 Appropriations Act in the wake of the near chapter 9 municipal bankruptcy of Petersburg, a subcommittee which has been tasked with a broad examination of local government fiscal stress, including disparity in taxing authority between cities and counties and local responsibility for delivery of state-mandated services, but also to examine potential incentives to encourage regional cooperation and possible savings obtained from such efforts, that four localities−two cities and two counties−are showing signs of potentially serious fiscal stress. While Auditor Mavredes did not publicly identify the four localities, she did request time first to notify the four and to open discussions to determine whether the initial financial assessments are accurate.

In this instance, the municipalities include one city, known only as City A, which, under the new state fiscal rating system, scored even lower than Petersburg in an assessment of data from 2016 under the “financial assessment model” designed by the auditor and a high-level work group based on a similar system in Louisiana. Both cities scored below 5 on a system which uses 16 as the minimum threshold for indicating financial stress. One other city and two counties scored below 16, and two localities, Hopewell and Manassas Park, have yet to submit financial data for 2016. (Indeed, Hopewell has failed so far to even submit a financial statement for FY2015.) Or, as the Auditor noted in her testimony: “I can’t even review the numbers of these places…I don’t have the data.”

Subcommittee Chairman Emmett W. Hanger Jr. (R-Augusta) concurred that it would be premature to identify the localities prior to notifying them and verifying the numbers used to assess them; however, other Virginia legislative leaders questioned whether the state is doing its job by not sharing concerns with the public—or, as House Appropriations Chairman S. Chris Jones (R-Suffolk) noted: “I think we would want to know those who are below 16: Knowing and not taking any affirmative actions is almost malfeasance.” As a former Mayor, it would seem Chairman Jones knew of what he was speaking. His perspective was reinforced by Senate Majority Leader Thomas K. Norment Jr. (R-James City), who co-chairs the Senate Finance with Sen. Hanger, who noted: “It’s important that we know, and it’s important that they know we know.”

While Virginia does not specifically authorize its municipal entities to file for chapter 9 municipal bankruptcy, the state does bar any of its cities or towns from incurring debt in excess of 10% of its assessed property valuation (see §1762), the Commonwealth has no authority to intervene directly in a locality’s finances, albeit Virginia Secretary of Finance Richard D. Brown played a critical role in halting, as we have previously noted, Petersburg’s near insolvency via the provision of state technical support on a voluntary basis to the distressed small city when it was confronted by nearly $19 million in unpaid bills—a fiscal precipice which led both the Virginia Legislature and Gov. Terry McAuliffe to recognize the importance of determining whether there might be increasing fiscal disparities within the state—and whether the state might be able to play a greater role in averting other potential municipal fiscal risks—leading to provisions in last year’s budget to direct the Virginia Auditor to create a municipal fiscal monitoring system to identify potentially stressed localities and offer to help, appropriating up to $500,000 as an incentive to cooperate.

And it appears the Legislature is impressed—or, as Chair Hanger said to Auditor Mavredes: “I’m impressed that you and your team stood this up as quickly as you did.” The new system the Auditor’s team put together examines the Comprehensive Annual Financial Reports submitted to the auditor annually and scores them on 10 financial ratios−including four which measure the health of the locality’s general fund used to finance its budget. That first fiscal scorecard identified Petersburg as the sole municipality publicly identified with a score which fell below the stress threshold for the past three years, reaching 4.48 in 2016, when its increasingly desperate fiscal situation became public. Auditor Mavredes told the legislative leaders: “Petersburg is a locality I would have wanted to look at, having seen these scores without knowing anything else.” 

Nevertheless, Petersburg is not the sole city the Auditor found to be in fiscal trouble: she testified that “City A” also scored below the threshold the last three years, dropping to 4.25 in 2016, testifying: “This is a city (on which) I will be doing follow-up.” In addition, she said she plans to contact at least three other localities, noting that City B fell precipitously from a score just under 50 in 2014 to between 13 and 14 in each of the next two years. She told the legislator her first question is whether the data used in the 2014 assessment are correct. She noted that County A demonstrates what Auditor Mavredes deemed “consistently low scores,” from just under 6 in 2014, to 8.23 the next year, and 7.31 last year; County B declined sharply from a score of 21 in 2014 to under 16 the next year and just over 11 in 2016, leading Co-Chair Jones to comment: “That seems to me to be a huge drop over a two-year period.” However, Ms. Mavredes responded the cause of the drop could be as simple and as unavoidable as the loss of a major employer, which is why she testified she intends to follow-up with the locality to determine what happened. Chairman Jones made clear his preference would be that such a fiscal examination take place in public view—or, as he put it: “If they’re not doing A, B, C, I think the public ought to know what is happening in that community.”

Fiscal Omens for the Motor City? Even as Detroit continues to recover from the largest municipal bankruptcy in U.S. history, the recovery continues to be uneven, and now there appears to be an emerging threat to its fiscal future: the number of families with children has declined by 43 percent since 2000 with only about a quarter of households with children, according to a report released this week from the nonprofit Detroit Future City, which also detailed a slowing population decline and job growth. In its report, “139 Square Miles,” the average size of Detroit households has declined over the past decade, with an average 2.6 people per household: Detroit households with children now make up 26 percent of the city, a steep, nearly 33 percent drop from 2000, with the data taking into account other types of households in the city which also experienced a decline. Today, in the Motor City, non-family households make up about 44 percent and households without children, about 31 percent. That compares to seventeen years ago, when, according to Edward Lynch, a planner for Detroit Future City, there were 115,000 families with children living in Detroit compared to only 65,000 families with children by 2015. Mr. Lynch noted: “We didn’t look specifically into the causes, but a lot of people point to different things (such as) schools as to why people have been moving out of the city for quite some time.” Unsurprisingly, but certainly related, is the state of enrollment at the Detroit Public Schools Community District, which is itself emerging from fiscal insolvency, even as it is experiencing ongoing decline: since the 2010-11 school year, the district has experienced a 41% enrollment decline: more than 30,000 students, even as charter school enrollment has increased 14%. Mr. Lynch notes: “We’re trying to provide a baseline analysis of the City of Detroit as it stands at this point in time…We’re hoping this will be used by a broad range of stakeholders and residents to get a clear picture of what’s happening at this point.”

On the plus side, Detroit Future City reports that for the first time in six decades, Detroit’s population decline has slowed, in no small part due to the job growth since the Great Recession: since the first quarter of 2010, Detroit has added 30,000 private-sector jobs, bringing the total jobs in the city to 238,400. The areas of growth include business services, automotive, financial services, and production technology. Perhaps better gnus: the largest increase in jobs has been among those that pay more than $40,000 annually.

ReGrowing in the Wake of Chapter 9. Even as the City of Detroit has razed more than 12,000 blighted houses over the past four years, the challenge of razing or relocating abandoned commercial structures—structures which can be safety threats to the community—has proved more difficult. Moreover, unlike the case with commercial buildings, the city may not make use of federal funds to tear down commercial properties—a stiff challenge, as some 83% of the city’s initial blight force list of over 5,400 blighted commercial properties, of which some 83% had been privately owned. Unsurprisingly, with November’s mayoral election not so far off, the issue has been drawn into the campaign, with the Mayor proposing to double the rate of demolitions to 300—a still challenge as, at least as of the day before yesterday, only 67 have come down. A spokesperson for the Mayor, John Roach, reports that, as of last week, some 97 commercial demolitions were at various stages in the razing pipeline: 18 buildings are currently ready to be razed, while the city sorts through the bidding and contract approval process—and the city’s auditors are assessing the residential demolition program to gain important lessons learned, especially in the wake of changes to the contracting process which mandated that each demolition gain approval from both the Detroit City Council and the Detroit Financial Review Commission.

More and more people are interested in moving downtown; however, the amount of new housing units has not been able to keep up with demand, a new study released Thursday by the Downtown Detroit Partnership said. In its third installment, the Greater Downtown Residential Market Study found that demand for market-rate and affordable housing in the area will grow by nearly 10,000 units over the next five years. The study, commissioned in part by Invest Detroit and conducted by Clinton, N.J.-based Zimmerman Volk Associates Inc., examined the Downtown, Corktown, Rivertown, Lafayette Park, Eastern Market, Midtown, Woodbridge, TechTown and New Center neighborhoods. “We’re seeing a continued demand for residential units, and that demand is increasing faster than the current supply of available units,” DDP CEO Eric Larson said in a statement. “There is a great opportunity in the city for developers for both market-rate and affordable units.”  While the area’s housing demand is projected to swell over the next five years, developers have proposed building roughly 7,400 units over the next three years, shy of the 10,000 projection over five years. Annual demand is projected to be as high as 2,000 units. The study found that 1,750 units have gone up in 2017. Of those units projected to be built in the next three years, 74 percent are forecast to be market-rate rentals and the rest affordable housing. Affordable housing includes those with incomes between 30 and 80 percent of the area’s median income.

Investing in Puerto Rico’s Future. Puerto Rico Gov. Ricardo Rossello has signed into law four of the five bills approved by the legislature in the extraordinary session that ended last week, including the new statute to guarantee the payment to Puerto Rico’s pensioners and establish a new defined contribution plan for public servants, or, as the Governor noted: “This first special session assured that retirees receive their pensions and that we comply with the Fiscal Plan so that we can continue to provide government services to the people.” The new law is intended to create a legal framework so that Puerto Rico can guarantee payments to its retirees via a “pay as you go” system, or, as the Governor noted: “To leave things as they were would have turned out that as soon as in September, our retirees would not receive the payment of their pension for which they worked for decades in the public service.” Under the new provisions, the General Fund will allocate $ 2 billion this year so that retirees continue to receive their monthly pensions; the bill also creates a Defined Contribution Plan, similar to a 401k, with Gov. Rossello noting: “In the past, public servants were held back by a percentage of their salary and went on to a trust that was used to pay for the administrative expenses and inefficiencies of the Government…That irresponsible practice ended with our Administration.”

Gov. Rossello also signed House Bill 1162, which makes technical amendments to the statute which created the Commission of the Equality for Puerto Rico, to incorporate the results of the plebiscite of June of 2017, providing that the members of the Commission shall not receive any remuneration for their services, noting that “this recommendation of amendment we receive[d] from baseball superstar Ivan Rodriguez so that the expenses of the members of the Commission are not met with public funds in the face of the fiscal situation that the Government is going through…I told the people of Puerto Rico from the electoral process that a vote for this server was a vote for statehood and a government that seeks equality at the national level as American citizens.”

The Fiscal Straits of Federalism: constitutional, fiscal, and human challenges for state and local leaders.

08/11/17

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Good Morning! In this a.m.’s blog, we consider the dire state of Hartford, Connecticut and the ongoing constitutional and fiscal challenges to the U.S. territory of Puerto Rico.

Fiscal Heart for Hartford? With no state budget in sight, the first day of school looming, Moody’s this week gloomily wondered whether the capitol city can avoid chapter 9 municipal bankruptcy via a path of debt restructuring and labor concessions as it contemplates looming debt payments of $3.8 million next month, and then $26.9 million in tax anticipation note payments in October. Moreover, given the grim state of Connecticut’s own fisc—upon which Hartford relies for half its municipal budget, Halloween could bring more than fiscal ghouls. Its options, moreover, as we have previously noted, are slim: with one fifth of its municipal budget composed of fixed costs, the option of increasing taxes—in a city with the highest tax rates in the state—would risk the loss of key businesses, potentially reducing, rather than increasing vital revenues. Thus, the challenge of meeting increased debt service costs and rising OPEB and pension obligations seem to more and more point to municipal debt restructuring.

If anything, the fiscal challenge is further complicated by the uncertainty on the state front: Connecticut has yet to adopt the budget for the fiscal year that began on July 1st: legislators have been unable to achieve consensus on a new two-year plan the governor will sign to address the state’s own projected $3.5 billion deficit. Indeed, Gov. Daniel P. Malloy’s budget, which proposes shifts of state education aid from wealthier communities to poorer communities, promises difficult negotiations with an uncertain outcome. Patrice McCarthy, the deputy director and general counsel at the Connecticut Association of Boards of Education, warned that while there were previous state budget impasses in 1991 and 2009, this year could be much worse for public school officials: “In those years, while we didn’t have a finalized budget, people had a better idea in each community about how much they’d be receiving: This year, everything is up in the air.”

Fundido. In Latin America, the word fundido can be translated to “dead beat;” while in English, the old expression that one cannot beat a dead horse might seem apt for the challenge confronting U.S. District Judge Laura Taylor Swain, who is presiding over the PROMESA version of a chapter 9 municipal bankruptcy process—a process created under the statute adopted by Congress which Theodore Olson, the former Solicitor General of the United States, this week described in an op-ed to the Wall Street Journal as a law which blatantly violates the Appointments Clause of the U.S Constitution.

Judge Swain this week approved an agreement intended to address creditors’ competing claims with regard to Puerto Rico’s sales tax revenue by the end of this year as part of an effort to resolve an agreement between the island’s two biggest creditor classes, General Obligation bondholders and COFINA bondholders, in part through appointing an agent for each side—agents charged with pursuing the best resolution for their debtor’s estate as a whole, as opposed to advocating for particular creditors of that debtor. (COFINA’s bonds are backed by Puerto Rico’s sales and use tax revenue, unlike Puerto Rico’s General Obligation debt, which carries a constitutional guarantee providing a claim on all of Puerto Rico’s revenues.) Thus, unsurprisingly, Judge Swain had been placed in the position of Solomon: she could threaten to cut the baby in half if the two sides do not reach an agreement by December 15th.  Here, the judicial combatants, who, together, claim to hold approximately half the U.S. territory’s $72 billion in debt, are fighting over which side has the primary claim on sales and use tax revenues.

Separately, Judge Swain this week has held off on responding to a request by creditors of Puerto Rico’s bankrupt power utility, PREPA, to appoint a receiver at the agency, denying a motion by a group of cities and towns to form an official committee in the case, whose attorneys’ fees would be paid by the island’s bankruptcy estate. Judge Swain informed the parties it was unclear whether the municipalities had valid claims against Puerto Rico’s government, a claim which, as we have previously noted, is critical, as Michael Rochelle, an attorney for the muncipios, told the judge his clients are confronted with budget cuts of as much as 50 percent; he plead: “This place will become Greece…We will have municipalities needing to be bankrupted.” Increasingly, too, there are fears that exorbitant legal fees, fees which some experts believe could run to in excess of $1 billion, are coming at the expense of Puerto Rico’s future. In so informing the muncipios, Judge Swain rejected a motion by several municipalities to have a committee representing their interests in Puerto Rico’s Title III case: she said that §1102 of the bankruptcy code allowed committees for creditors or equity security holders, but the municipalities are not the latter, and the municipalities’ principal concerns are not those of being creditors, adding that the municipalities are adequately represented without having their own committee.

The president of the Association of Puerto Rico Mayors, Rolando Ortiz, yesterday made clear the gravity of the fiscal situation, warning that 45 municipalities will be inoperative as early as the close of the fiscal year, under the fiscal plan submitted by Gov. Ricardo Rosselló and certified by the Federal Fiscal Control Board. He noted that the proposal would eliminate a loan of some $350 million, which was granted to municipalities in exchange for exempting public corporations from paying the tax on real property—or, as he stated: “From the fiscal point of view, it leaves us without protection of the judicial apparatus of the country and limits our capacity to serve to the citizens to the extent that they take away resources that we have always used to help the people that we attend in the different cities.”

Indeed, it appears the fiscal impact has already begun to have an effect on the pockets of municipal employees, who have experienced reductions in working hours in 22 municipalities: Arroyo, Toa Alta, Cabo Rojo, Yauco, Las Piedras, Juana Diaz, Comerío, Vieques, Aguadilla, Mayagüez, Toa Baja, Salinas, Adjuntas, Vega Baja, Sabana Grande, Villalba, and Trujillo Alt; five other municipalities had applied the reduction of working hours in previous years. (Ponce, Ciales, Luquillo, Maunabo, and Camuy.) The likely next step, he warned, would be that more municipalities will join the lawsuits filed by the municipalities of San Juan and Caguas—litigation in response to which they said: “The decision of (Judge Swain) what she is going to bring is more cases on the part of the municipalities.” The Mayor of Caguas, a municipality  founded in 1775 of about 150,000 located in the Central Mountain Range, William Miranda Torres, regretted the closure of the judicial door to the municipalities, describing it as a “scenario where they have made decisions, by blow and blow, to make use of our monies without allowing us fair participation,” describing it as “clear discrimination against the municipalities,” noting that the municipalities offer direct services to the citizenry, including  maintenance to infrastructure, health, safety, emergency management, programs to the elderly, garbage collection, cultural programs, fine arts programs and sports programs—adding: “The central government has been stripping municipalities of important resources to provide essential services that will now be very difficult to cover. The humanitarian crisis has come and closing doors give us very few possibilities to fight it from where we can best do it.”

For her part, San Juan Mayor Carmen Yulin Cruz recalled that her municipality continues along the route to sue under PROMESA’s Title VI, even as she praised the management of mayors who filed their appeal by way of Title III: “If the judge (Judge Swain) said it was not for Title III, at least those comrades dared to challenge PROMESA.”

Addressing Municipal Fiscal Distress at the White House and State House

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07/31/17

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Good Morning! In today’s Blog, we consider whether President Trump’s appointment of new White House Communications Director of Communications might have fiscal implications for Puerto Rico’s fiscal future; then we turn to leadership efforts in the Virginia General Assembly to refine what a state’s role in oversight of municipal fiscal distress might be. 

Might There Be a Change in White House Direction vis-à-vis Puerto Rico? Prior to his new appointment as White House Director of Communications, Anthony Scaramucci, more than a year ago, questioned whether the U.S. territory of Puerto Rico should be granted authority more akin to a sovereign nation than a state—power which would, were it granted, authorize Puerto Rico to authorize its muncipios the authority to file for chapter 9 municipal bankruptcy, writing in an op-ed, “The shame of leaving Puerto Rico in limbo,” in Medium a year ago last May, just as the U.S. House Natural Resources Committee was seeking to report the PROMESA legislation. Mr. Scaramucci then indicated that creditors wanted to file with regard to the actions taken by the Puerto Rican government as if they were “equal to the intransigence of the Kirchner government in Argentina, but in reality the situations (of both countries) are completely different.” He explained: Not only does Puerto Rico not have the same public policy options as Argentina, but its economy and ability to pay its debts are worse off: Not only does Puerto Rico not have the same public policy options as Argentina, but its economy and ability to pay its debts are worse off.” He further noted that House Speaker Paul Ryan (R.-Wis.) was in a difficult situation to deal with the situation in Puerto Rico, amid what he described as a “civil war” within the Republican Party—a war he described as “induced by Donald Trump.”

Now, of course, Mr. Scaramucci is in a starkly different position—one where he might be able to influence White House policy. Having written, previously, that the “tax code of the Commonwealth must be revised to be more friendly to economic development…Social assistance programs should be drastically reduced and labor laws softened,” Mr. Scaramucci has also called for public-private partnerships to make “essential” government services more efficient, such as the Puerto Rico Electric Power Authority—noting: “Ultimately…we must also allow Puerto Rico to operate as a sovereign country or grant them legal protections more similar to those of the states (which is the preference of the Puerto Rican people).” He argued that the case of Puerto Rico represents a “failure on multiple levels: the insatiable desire of US investment funds for Puerto Rico triple exemption bonds; U.S. Congressmen of the status of the Congressionally-created territory, and misappropriation of funds by the Puerto Rican government: “We must now face our failures and take pragmatic measures to create a better future:  The tax code of the Commonwealth must be revised to be more friendly to economic development; social assistance programs should be drastically reduced, and labor laws softened.” He noted that public-private partnerships could be vital in rendering “essential” government services more efficient, such as the Puerto Rico Electric Power Authority, noting: “Ultimately, we must also allow Puerto Rico to operate as a sovereign country or grant them legal protections more similar to those of the states (which is the preference of the Puerto Rican people).” Referencing that, as in the Great Recession of 2008, he noted the case of Puerto Rico represents a “failure on multiple levels: the insatiable desire of US investment funds for Puerto Rico triple exemption bonds; U.S. Congressmen of the status of ELA (Estado Libre Asociado de Puerto Rico), and misappropriation of funds by the Puerto Rican government…But as we did after 2008, we must now face our failures and take pragmatic measures to create a better future.”

Mr. Scaramucci’s comments came as the City or Pueblo of San Juan has filed a legal challenge to the PROMESA Oversight Board’s approval of the Government Development Bank (GDB) for Puerto Rico debt restructuring agreement: San Juan is seeking a declaratory judgement and injunctive relief against the PROMESA Oversight Board, the GDB, and the Puerto Rico Fiscal Agency and Financial Advisory Authority before U.S. Judge Laura Swain Taylor in the U.S. District Court for Puerto Rico—a judge by now immersed in multiple bankruptcy filings, after the Bastille Day PROMESA Board’s approval of a restructuring agreement for the GDB’s $4.8 billion in debt—an approval for which the Board asserted it had authority under PROMESA’s Title VI.

San Juan’s filing claims the GDB holds more than $152 million in San Juan deposits—deposits which the city asserts are the property of San Juan, and thereby ineligible for Title VI restructuring, which explicitly addresses only municipal bonds, loans, and other similar securities. San Juan then claims the GDB deposits are “secured,” unlike the funds which the GDB owes to municipal bondholders—even as the PROMESA Board’s approved Restructuring Support Agreement provides for the municipalities to vote in the same class as all the other GDB creditors, asserting that such a voting practice would be contrary to PROMESA. The suit also notes that, under Puerto Rico statutes, municipal depositors are allowed to set-off their deposits against their GDB loan balances; however, the Restructuring Support Agreement (RSA) is grossly inaccurate in accounting for these deposits against the loans and, thus, the agreement is breaching the law—asserting:

“The ultimate effect of the RSA would be to provide a windfall to the GDB’s bondholders by using the resources of San Juan and other municipalities for the payment of bondholder claims while imposing enormous losses on those same municipal depositors through the confiscation of their excess [special tax deposit] and their statutorily guaranteed right to setoff deposits at the GDB against their loans from the GDB.” The suit further charged that the PROMESA Board convened illegal executive private sessions concerning the creation of the RSA—sessions which included representatives of the GDB and FAFAA. (The federal statute only allows executive sessions with board members and its staff present, according to the suit.)  Thus, in its complaint , the city is requesting that Judge Swain find the board’s approval of the agreement invalid, and that Judge Swain further find that PROMESA and Article VI, Clause 2 of the U.S. Constitution preempt Puerto Rican laws and executive order that have stopped the municipalities from withdrawing their funds from the GDB for over a year.

Not Petering Out. In the Virginia Legislature, Del. Lashrecse Aird (D-Petersburg), the youngest woman ever elected to the House of Delegates, recently noted: “In this session, I’m carrying a very light load, just four or five bills, that are locality bill requests: As a lawmaker overall, you will always see me supporting those initiatives and those policy issues that reference those three priorities: jobs, education, and healthcare. I think that if I can execute on those priorities, that will definitely improve the quality of life for the citizens, the families and kids, not just for Petersburg but the entire district.” Del. Air noted that last year, the City of  Petersburg’s financial situation made headlines throughout the Commonwealth, and led to serious conversations about the financial health of Virginia’s cities and counties: “What we saw in Petersburg, in addition to a declining economy nationwide, was longstanding financial mismanagement, negligence, and declining cash balances dating back to 2009. And, what we saw in localities like Emporia, Martinsville, Lynchburg, Buena Vista—all classified as having significant fiscal stress—is that these historic cities were displaying similar indicators, and they were largely going unaddressed.” Thus, she played a key role in creating a work group which has examined local fiscal distress—and which has produced an action plan, a plan from which components have been incorporated into the state’s new budget: including:

  • improving how the Commonwealth of Virginia monitors fiscal activity and increases the level of oversight by the auditor of public accounts;
  • establishing a mechanism which is responsive to situations of local fiscal distress; and
  • providing readily available resources should intervention become necessary.

As a start, she noted that Virginia House has adopted a budget which allocates up to $500,000 to conduct intervention and remediation efforts in situations of local fiscal distress that have been previously documented by the Office of the State Secretary of Finance prior to January 1st, 2017. As part of a longer-term approach, the effort incorporates additional language establishing a Joint Subcommittee on Local Government Fiscal Stress, with the new subcommittee charged to review:

  • savings opportunities for increased regional cooperation and consolidation of services;
  • local responsibilities for service delivery of state-mandated or high-priority programs;
  • causes of fiscal stress; potential financial incentives and other governmental reforms for regional cooperation; and
  • the different taxing authorities of cities and counties.

Or, she she put it:

“An integral part of the approach we take towards addressing fiscal distress must also include conversations about electing capable local leadership and providing training in areas most critical to effective governance and financial management. Where there are gaps in knowledge and understanding, elected officials must be willing to educate themselves in every area necessary for good governance.”

A Hole in Puerto Rico’s Fiscal Safety Net: Should Congress Amend Chapter 9 Municipal Bankruptcy?

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Good Morning! In this a.m.’s eBlog, we consider the growing physical and fiscal breakdown in the U.S. Territory of Puerto Rico as it seeks, along with the oversight PROMESA Board, an alternative to municipal bankruptcy—but we especially focus on the fiscal plight of the territory’s many, many municipalities—or muncipios, which, because Puerto Rico is not a state, do not have access to chapter 9 municipal bankruptcy .   

Tropical Fiscal Typhoon. When former President Ronald Reagan signed Public Law 100-597, legislation authorizing municipal into law 29 years ago, no one was contemplating a U.S. territory, such as Puerto Rico—so that the federal statute, in coherence and compliance with the concepts of dual sovereignty, which served as the unique foundation of the nation, provided that a city, county, or other municipality could only file for chapter 9 if authorized by state law—something a majority of states have not authorized. Unsurprisingly, none of us contemplated or thought about U.S. territories, such as Puerto Rico, Guam, etc.: Puerto Rico is to be considered a state for purposes of the bankruptcy code, except that, unlike a state, it may not authorize its municipalities (and by extension, its utilities) to resolve debts under Chapter 9 of the code. Ergo, no municipio in Puerto Rico has access to a U.S. bankruptcy court, even as 36 of the island’s 78 muncipios have negative budget balances; 46% are experiencing fiscal distress. Their combined total debt is $3.8 billion. In total, the combined debt borne by Puerto Rico’s municipalities is about 5.5% of Puerto Rico’s outstanding debt.  

The fiscal plight of Puerto Rico’s municipalities has also been affected by the territory’s dismal fiscal condition: From 2000 to 2010, the population of Puerto Rico decreased, the first such decrease in census history for Puerto Rico, declining by 2.2%; but that seemingly small percentage obscures a harsher reality: it is the young and talented who are emigrating to Miami, New York City, and other parts on the mainland, leaving behind a declining and aging population—e.g. a population less able to pay taxes, but far more dependent on governmental assistance. At the same time, Puerto Rico’s investment in its human infrastructure has contributed to the economy’s decline: especially the disinvestment in its human infrastructure: a public teacher’s base salary starts at $24,000—even as the salary for a legislative advisor for Puerto Rico starts at $74,000. That is, if Puerto Rico’s youngest generation is to be its foundation for its future—and if its leaders are critical to local fiscal and governing leadership in a quasi-state where 36 of the island’s 78 municipalities, or just under half, are in fiscal distress—but, combined, have outstanding debt of about $3.8 billion; something will have to give. These municipalities, moreover, unlike Detroit, or San Bernardino, or Central Falls, have no recourse to municipal bankruptcy: they are in a fiscal Twilight Zone. (Puerto Rico has a negative real growth rate; per capita income in 2010 was estimated at $16,300; 46.1% of the territory’s population is in poverty, according to the most recent 2106 estimate; but that poverty is harsher outside of San Juan.) A declining and aging population adversely affects economic output—indeed, as former Detroit Emergency Manager Kevyn Orr who steered the city out of the largest municipal bankruptcy in U.S. history recognized, the key to its plan of debt adjustment was restoring its economic viability.

U.S. Supreme Court Justice Sonia Sotomayor, who is of Puerto Rican descent, has indicated there should be a more favorable interpretation of the law to make the system fairer to Puerto Rico: to allow the Commonwealth of Puerto Rico to create its own emergency municipal bankruptcy measures—something, however, which only Congress and the Trump administration could facilitate. It seems clear that Justice Sotomayor does believe Puerto Rico ought to be considered the equivalent of a state, i.e. empowered to create its own bankruptcy laws. However, as the First Circuit Court of Appeals has interpreted, Puerto Rico is barred from enacting its own bankruptcy laws: it is treated as a state—in a country of dual federalism wherein the federal government, consequently, has no authority to authorize state access to bankruptcy protection.

What Lessons Can State & Local Leaders Learn from Unique Fiscal Challenges?

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eBlog, 04/25/17

Good Morning! In this a.m.’s eBlog, we consider the unique fiscal challenges in Michigan and how the upswing in the state’s economy is—or, in this case, maybe—is not helping the fiscal recovery of the state’s municipalities. Then we remain in Michigan—but straddle to Virginia, to consider state leadership efforts in each state to rethink state roles in dealing with severe fiscal municipal distress. Finally, we zoom to Chicago to glean what wisdom we can from the Godfather of modern municipal bankruptcy, Jim Spiotto: What lessons might be valuable to the nation’s state and local leaders?  

Fiscal & Physical Municipal Balancing I. Nearly a decade after the upswing in Michigan’s economic recovery, the state’s fiscal outlook appears insufficient to help the state’s municipalities weather the next such recession. Notwithstanding continued job growth and record auto sales, Michigan’s per-capita personal income lags the national average; assessed property values are below peak levels in 85% of the state’s municipalities; and state aid is only 80% of what it was 15 years ago.  Thus, interestingly, state business leaders, represented by the Business Leaders for Michigan, a group composed of executives of Michigan’s largest corporations universities, is pressing the Michigan Legislature to assume greater responsibility to address growing public pension liabilities—an issue which municipal leaders in the state fear extend well beyond legacy costs, but also where fiscal stability has been hampered by cuts in state revenue sharing and tax limitations. Michigan’s $10 billion general fund is roughly comparable to what it was nearly two decades ago—notwithstanding the state’s experience in the Great Recession—much less the nation’s largest ever municipal bankruptcy in Detroit, or the ongoing issues in Flint. Moreover, with personal income growth between 2000 and 2013 growing less than half the national average (in the state, the gain was only 31.1%, compared to 66.1% nationally), and now, with public pension obligations outstripping growth in personal income and property values, Michigan’s taxpayers and corporations—and the state’s municipalities—confront hard choices with regard to “legacy costs” for municipal pensions and post-retirement health care obligations—debts which today are consuming nearly 20 percent of some city, township, and school budgets—even as the state’s revenue sharing program has dropped nearly 25 percent for fiscally-stressed municipalities such as Saginaw, Flint, and Detroit just since 2007—rendering the state the only state to realize negative growth rates (8.5%) in municipal revenue in the 2002-2012 decade, according to numbers compiled by the Michigan Municipal League—a decade in which revenue for the state’s cities and towns from state sources realized the sharpest decline of any state in the nation: 56%, a drop so steep that, as the Michigan Municipal League’s COO Tony Minghine put it: “Our system is just broken…We’re not equipped to deal with another recession. If we were to go into another recession right now, we’d see widespread communities failing.” Unsurprisingly, one of the biggest fears is that another wave of chapter 9 filings could trigger the appointment of the state’s ill-fated emergency manager appointments. From the Michigan Municipal League’s perspective, any fiscal resolution would require the state to address what appears to be a faltering revenue base: Michigan’s taxable property is appreciating too slowly to support the cost of government (between 2007 and 2013, the taxable value of property declined by 8 percent in Grand Rapids, 12% in Detroit, 25% in Livonia, 32% in Warren, 22% in Wayne County values, and 24% in Oakland County.) The fiscal threat, as the former U.S. Comptroller General of the General Accounting Office warned: “Most of these numbers will get worse with the mere passage of time.”

Fiscal & Physical Municipal Balancing II. Mayhap Michigan and Virginia state and local leaders need to talk:  Thinking fiscally about a state’s municipal fiscal challenges—and lessons learned—might be underway in Virginia, where, after the state did not move ahead on such an initiative last year, the new state budget has revived the focus on fiscal stress in Virginia cities and counties, with the revived fiscal focus appearing to have been triggered by the ongoing fiscal collapse of one of the state’s oldest cities, Petersburg. Thus, Sen. Emmett Hanger (R-Augusta County), a former Commissioner of the Revenue and member of the state’s House of Delegates, who, today, serves as Senate Finance Co-Chair, and Chair of the Health and Human Services Finance subcommittee, has filed a bill, SJ 278, to study the fiscal stress of local governments: his proposal would create a joint subcommittee to review local and state tax systems, as well as reforms to promote economic assistance and cooperation between regions. Although the legislation was rejected in the Virginia House Finance Committee, where members deferred consideration of tax reform for next year’s longer session, the state’s adopted budget does include two fiscal stress preventive measures originally incorporated in Senator Hanger’s proposed legislation—or, as co-sponsor Sen. Rosalyn Dance (D-Petersburg), noted: “Currently, there is no statutory authority for the Commission on Local Government to intervene in a fiscally stressed locality, and the state does not currently have any authority to assist a locality financially.” To enhance the state’s authority to intervene fiscally, the budget has set guidelines for state officials to identify and help alleviate signs of financial stress to prevent a more severe crisis. Thus, a workgroup, established by the auditor of public accounts, would determine an appropriate fiscal early warning system to identify fiscal stress: the proposed system would consider such criteria as a local government’s expenditure reports and budget information. Local governments which demonstrate fiscal distress would thence be notified and could request a comprehensive review of their finances by the state. After a fiscal review, the commonwealth would then be charged with drafting an “action plan,” which would provide the purpose, duration, and anticipated resources required for such state intervention. The bill would also give the Governor the option to channel up to $500,000 from the general fund toward relief efforts for the fiscally stressed local government.

Virginia’s new budget also provides for the creation of a Joint Subcommittee on Local Government Fiscal Stress, with members drawn from the Senate Finance Committee, the House Appropriations, and the House Finance committees—with the newly created subcommittee charged to study local and state financial practices, such as: regional cooperation and service consolidation, taxing authority, local responsibilities in state programs, and root causes of fiscal stress. Committee member Del. Lashrecse Aird (D-Petersburg) notes: “It is important to have someone who can speak to first-hand experience dealing with issues of local government fiscal stress…This insight will be essential in forming effective solutions that will be sustainable long-term…Prior to now, Virginia had no mechanism to track, measure, or address fiscal stress in localities…Petersburg’s situation is not unique, and it is encouraging that proactive measures are now being taken to guard against future issues. This is essential to ensuring that Virginia’s economy remains strong and that all communities can share in our Commonwealth’s success.”

Municipal Bankruptcy—or Opportunity? The Chicago Civic Federation last week co-hosted a conference, “Chicago’s Fiscal Future: Growth or Insolvency?” with the Federal Reserve Bank of Chicago, where experts, practitioners, and academics from around the nation met to consider best and worst case scenarios for the Windy City’s fiscal future, including lessons learned from recent chapter 9 municipal bankruptcies. Chicago Fed Vice President William Testa opened up by presenting an alternative method of assessing whether a municipality city is currently insolvent or might become so in the future: he proposed that considering real property in a city might offer both an indicator of the resources available to its governments and how property owners view the prospects of the city, adding that, in addition to traditional financial indicators, property values can be used as a powerful—but not perfect—indicators to reflect a municipality’s current situation and the likelihood for insolvency in the future. He noted that there is considerable evidence that fiscal liabilities of a municipality are capitalized into the value of its properties, and that, if a municipality has high liabilities, those are reflected in an adjustment down in the value of its real estate. Based upon examination, he noted using the examples of Chicago, Milwaukee, and Detroit; Detroit’s property market collapse coincided with its political and economic crises: between 2006 and 2009-2010, the selling price of single family homes in Detroit fell by four-fold; during those years and up to the present, the majority of transactions were done with cash, rather than traditional mortgages, indicating, he said, that the property market is severely distressed. In contrast, he noted, property values in Chicago have seen rebounds in both residential and commercial properties; in Milwaukee, he noted there is less property value, but higher municipal bond ratings, due, he noted, to the state’s reputation for fiscal conservatism and very low unfunded public pension liabilities—on a per capita basis, Chicago’s real estate value compares favorably to other big cities: it lags Los Angeles and New York City, but is ahead of Houston (unsurprisingly given that oil city’s severe pension fiscal crisis) and Phoenix. Nevertheless, he concluded, he believes comparisons between Chicago and Detroit are overblown; the property value indicator shows that property owners in Chicago see value despite the city’s fiscal instability. Therefore, adding the property value indicator could provide additional context to otherwise misleading rankings and ratings that underestimate Chicago’s economic strength.

Lessons Learned from Recent Municipal Bankruptcies. The Chicago Fed conference than convened a session featuring our former State & Local Leader of the Week, Jim Spiotto, a veteran of our more than decade-long efforts to gain former President Ronald Reagan’s signature on PL 100-597 to reform the nation’s municipal bankruptcy laws, who discussed finding from his new, prodigious primer on chapter 9 municipal bankruptcy. Mr. Spiotto advised that chapter 9 municipal bankruptcy is expensive, uncertain, and exceptionally rare—adding it is restrictive in that only debt can be adjusted in the process, because U.S. bankruptcy courts do not have the jurisdiction to alter services. Noting that only a minority of states even authorize local governments to file for federal bankruptcy protection, he noted there is no involuntary process whereby a municipality can be pushed into bankruptcy by its creditors—making it profoundly distinct from Chapter 11 corporate bankruptcy, adding that municipal bankruptcy is solely voluntary on the part of the government. Moreover, he said that, in his prodigious labor over decades, he has found that the large municipal governments which have filed for chapter 9 bankruptcy, each has its own fiscal tale, but, as a rule, these filings have generally involved service level insolvency, revenue insolvency, or economic insolvency—adding that if a school system, county, or city does not have these extraordinary fiscal challenges, municipal bankruptcy is probably not the right option. In contrast, he noted, however, if a municipality elects to file for bankruptcy, it would be wise to develop a comprehensive, long-term recovery plan as part of its plan of debt adjustment.

He was followed by Professor Eric Scorsone, Senior Deputy State Treasurer in the Michigan Department of Treasury, who spoke of the fall and rise of Detroit, focusing on the Motor City’s recovery—who noted that by the time Gov. Rick Snyder appointed Emergency Manager Kevyn Orr, Detroit was arguably insolvent by all of the measures Mr. Spiotto had described, noting that it took the chapter 9 bankruptcy process and mediation to bring all of the city’s communities together to develop the “Grand Bargain” involving a federal judge, U.S. Bankruptcy Judge Steven Rhodes, the Kellogg Foundation, and the Detroit Institute of Arts (a bargain outlined on the napkin of a U.S. District Court Judge, no less) which allowed Detroit to complete and approved plan of debt adjustment and exit municipal bankruptcy. He added that said plan, thus, mandated the philanthropic community, the State of Michigan, and the City of Detroit to put up funding to offset significant proposed public pension cuts. The outcome of this plan of adjustment and its requisite flexibility and comprehensive nature, have proven durable: Prof. Scorsone said the City of Detroit’s finances have significantly improved, and the city is on track to have its oversight board, the Financial Review Commission (FRC) become dormant in 2018—adding that Detroit’s economic recovery since chapter 9 bankruptcy has been extraordinary: much better than could have been imagined five years ago. The city sports a budget surplus, basic services are being provided again, and people and businesses are returning to Detroit.

Harrison J. Goldin, the founder of Goldin Associates, focused his remarks on the near-bankruptcy of New York City in the 1970s, which he said is a unique case, but one with good lessons for other municipal and state leaders (Mr. Goldin was CFO of New York City when it teetered on the edge of bankruptcy). He described Gotham’s disarray in managing and tracking its finances and expenditures prior to his appointment as CFO, noting that the fiscal and financial crisis forced New York City to live within its means and become more transparent in its budgeting. At the same time, he noted, the fiscal crisis also forced difficult cuts to services: the city had to close municipal hospitals, reduce pensions, and close firehouses—even as it increased fees, such as requiring tuition at the previously free City University of New York system and raising bus and subway fares. Nevertheless, he noted: there was an upside: a stable financial environment paved the way for the city to prosper. Thus, he advised, the lesson of all of the municipal bankruptcies and near-bankruptcies he has consulted on is that a coalition of public officials, unions, and civic leaders must come together to implement the four steps necessary for financial recovery: “first, documenting definitively the magnitude of the problem; second, developing a credible multi-year remediation plan; third, formulating credible independent mechanisms for monitoring compliance; and finally, establishing service priorities around which consensus can coalesce.”

The Key Lessons Learned after a Decade of Municipal Bankruptcies

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eBlog, 04/07/17

Good Morning! In this a.m.’s eBlog, we consider Detroit’s first steps to address the blight which crisscrossed the city leading to its municipal bankruptcy. Then we look to New Hampshire to assess whether the state legislature will preempt municipalities’ authority to set election dates. Then we slip south to assess fiscal developments in the efforts to recover from insolvency in Puerto Rico. Finally, we assess and consider some of the broader issues related to municipal bankruptcy.

Post Chapter 9 Recovery. One of Detroit’s first tests with regard to whether it can find new use for the vast stretches of land it cleared of blight went into effect this week when development teams announced by  Mayor Mike Duggan, along with partners: The Platform, a Detroit-based firm, and Century Partners announced they would be investing an estimated $100 million to rehab the architectural jewels in the city’s downtown—the Fisher and Albert Kahn buildings, with the two organizations declaring they will take the lead in overhauling 373 parcels of vacant land and houses in the Fitzgerald neighborhood on the northwest side, where they will coordinate with other firms on a $4 million development plan to rehab 115 vacant homes over two years, create a two-acre park, and landscape 192 vacant lots—with the work occurring in neighborhoods wherein the Detroit Land Bank took control of most of the properties and razed some abandoned homes. Mayor Duggan and other officials described the plan as a kind of reverse gentrification—or, as Mayor Duggan framed it: “We are going to keep the families here while improving the neighborhoods,” making his announcement on an empty lot which is scheduled to become a city park and include a greenway path to nearby Marygrove College: the city leaders hope to transform the neighborhood into a “Blight-Free Quarter Square Mile,” and, if the model works, seek to propagate it other neighborhoods.

Granite State Preemption or Cure? House Speaker Shawn Jasper wants to give New Hampshire towns that postponed their municipal elections due to a snowstorm a way out of facing potential lawsuits from voters who may have been disenfranchised. Speaker Jasper had proposed letting towns ratify the results of their elections by holding another vote, offering a bill to give towns which moved Election Day the option of letting townspeople vote to ratify, or confirm, the results on May 23rd. However, in the wake of about five hours of testimony, the House Election Law Committee voted 10-10 on the Jasper plan, so that a tie vote killed the Speaker’s amendment, leaving 73 towns on their own to address potential legal problems resulting from their decisions to hold their elections on days other than March 14th. The fiscal blizzard in the Granite State now depends upon whether state legislators determine whether or not a special election is needed with regard to those results. New Hampshire Deputy Secretary of State David Scanlan noted: “The concept is not entirely new…what is different is that it is applying to an entire class of towns that decided to postpone.”

In the past, the Legislature has voted to “cure” individual election defects. Speaker of the House Shawn Jasper, (R-Hudson, N.H.) noted: “Well, the fact that a bunch of towns moved the day of their town election was unprecedented…And so as a result of doing that, those towns that moved had to start bending other laws to make other issues related to the election work…The Legislature is just granting the authority to allow the towns to correct any defects that may exist,” he added, listing changed time listings, lack of proper notice, and absentee ballot date issues as possible defects in the process. All of those questions, of course, have fiscal consequences—or, as Atkinson Town Administrator Alan Phair put it; “Well, I don’t know the exact cost, what it would be, but I do know that in our case we certainly don’t have the money budgeted to (hold a special election), because we obviously just budgeted for one election…We would certainly go considerably over and have to find the money elsewhere to do it.” Under the proposed amendment, towns and school districts which postponed would hold a hearing, at which the respective governing body would vote on whether to hold a special election with one question: whether or not to ratify results, where a “no” vote would kick out anyone elected in a postponed vote, while nullifying warrant articles, with elected roles to be appointed until the next election. Salem Town Manager (Salem is a town of just under 30,000 in Rockingham County) Leon Goodwin said his elected leaders were of the opinion that its postponement was legal, so that the municipality is moving forward on projects voted on last month, noting: We’re moving on as if the votes were accepted even though there is a cloud hanging over us from Concord,” adding that town counsel advised the town moderator that it was legal to move elections. Yet, even as he remained confident the election issue will be resolved, he cautioned that the town has not budgeted for an additional election; Windham (approximately 14,000) Town Manager David Sullivan said the municipality’s town Counsel would sign off on the town’s fire truck bond, notwithstanding bond counsel elsewhere in the state advising that ratification of the elections would be necessary.

Municipal authority to act has been hampered by different state House and Senate approaches: while the two bodies have been moving on parallel tracks in the wake of state officials’ questioning the authority of town moderators to reschedule the March 14 voting sessions of their town meetings, the Senate this week passed SB 248, a bill introduced to ratify actions taken at the rescheduled meetings; however, the bill passed with a committee amendment which deletes all of the original language and provides instead for the creation of a committee to “study the rescheduling of elections.” Senators acknowledged that the bill was not likely to pass through the House in that form—asserting the intent was simply to get a bill to the House for further work. Subsequently, a floor amendment was introduced to restore the bill’s original language, ratifying all actions taken at the rescheduled meetings; however, that amendment failed on a party-line vote, with all nine Democrats voting in favor and all fourteen Republicans voting against, leaving most unclear how this could have become a partisan issue. The question comes down to what level of control local officials should have over local elections. The Speaker described the outcome thusly: “I think it was a case of 10 people (on the committee) thinking that what happened was legal;” however, he maintained that the postponed votes were not legal, adding: “The sad thing is that for school districts with bond issues that passed in those meetings, I don’t see a path forward for them,” adding: “I think if you’re afraid of snowstorms, you ought to move your meetings, probably to May,” noting that state officials are forbidden by law from moving state primary and general elections, as well as the first-in-the-nation presidential primary. Unsurprisingly, town moderators and attorneys who work with them on municipal bond issues disagreed with the Speaker’s interpretation that the postponed elections were illegal and his belief that the only way to rectify the issue was for them to act to individually ratify them, with many arguing they acted legally under a state law which allows them to postpone and reschedule the “deliberative session or voting day” of a town meeting to another day; however, the Speaker maintains that law applies only to town meetings, while town elections are governed under a different statute, which provides: “All towns shall hold an election annually for the election of town officers on the second Tuesday in March.” He also noted that the state’s official political calendar, which has the force of law, states that town elections must be held on March 14, adding: “Without trying to place blame, laws are sometimes very confusing if you look only at parts of them,” noting: “I don’t believe for one second that moving the election was legal.”

The Speaker added that still another state law provides that at special town meetings, no money may be raised or appropriated unless the number of ballots cast at the meeting is at least half the number of those on the checklist who were eligible to vote in the most recent town meeting, albeit adding that such meetings do not apply to the current situation, because they are not elections. The state’s Secretary of State said that after three weeks of research, he was able to report on voter turnout at town elections for the past 11 years, advising that 210 towns held elections in March, and 137 of them “followed the law” by holding their elections on March 14th, while 73 towns had postponed their elections by several days. Now Speaker Jasper asks: “Why would we give over 300 individual moderators the ability to do that when our Secretary of State doesn’t have the ability to do that for a snowstorm in our general election or our presidential primary?” The Speaker notes: “I think we need to provide a way to ensure that we don’t clog up the courts, and we don’t have people spend a lot of their own money to fight this, and the towns don’t have to spend a lot of money fighting it.”

Un-positive Credit Rating for Puerto Rico. Moody’s Investors Service has lowered the credit ratings on debt of the Government Development Bank and five other Puerto Rico issuers, with a total of approximately $13 billion outstanding, and revised down the Commonwealth’s fiscal outlook, and the outlooks for seven affiliated obligors linked to the central government to negative from developing, with the downgrades reflecting what the agency described as “persistent pressures on Puerto Rico’s economic base that indicate a diminishing perceived capacity to repay,” noting that while it continues to “believe that essentially all of Puerto Rico’s debt will be subject to default and loss in a broad restructuring, the securities being downgraded face more severe losses than we had previously expected, in the light of Puerto Rico’s projected economic pressures. For this reason, we downgraded to C from Ca not only the senior notes issued by the now defunct Government Development Bank, but also bonds issued by the Puerto Rico Infrastructure Financing Authority and backed by federal rum tax transfer payments, the Convention Center District Authority’s hotel occupancy tax-backed bonds, the Employees Retirement System’s bonds backed by government pension contributions, and the 1998 Resolution bonds of the Puerto Rico Highways and Transportation Authority.”

Puerto Rico Governor Rossello late Wednesday said that the U.S. territory’s fiscal plan, approved by the PROMESA Board, does not contemplate any double taxation, adding that, between the increase in the property tax and the reduction of expenses in the municipalities, he favored the latter as a measure to compensate for the absence of the state subsidy of $350 million. He reiterated that, as a substitute for these funds, the properties which are not currently paying taxes to the Centro de Recaution de Ingresos Municipales (CRIM: the Municipal Revenue Collection Center) should be identified, because they are not included in their registry. The Governor also stressed that the economic outcome of these two fiscal initiatives is still being evaluated, albeit he estimated that they could generate about $100 million, noting: “Whatever the differential after that for the municipalities, there are two mechanisms that can be worked: One, a mechanism to seek an additional source of income, or, two, to avail cuts…The central government has taken the cutting position. We are already establishing a protocol to cut in the agencies, to consolidate, to eliminate the expenses that are not necessary, to go from 131 to between 35 to 40 agencies. That has been our action. The municipalities—now we will have a conversation with our technical team—will have several options: ‘either cut as did the central government or seek mechanisms to raise more funds or impose taxes.’” Currently, mayors evaluate to increase the arbitrage of the real property to 11.83% or to 12.83% in all the municipalities; the concept is for members of the Executive to offer assistance to do the modeling. Thus, the president of the board of CRIM, Cidra Mayor Javier Carrasquillo, said CRIM will be “sensitive to the reality of the pockets of Puerto Ricans: We have to be cautious and responsible in the recommendation that we are going to make…There is nothing definitive yet. There are recommendations.” The Governor noted that the PROMESA Board approved fiscal plan approved last month does not contemplate an increase in property taxation, asserting it was “false to imply that our fiscal plan entails an increase in the rate or a double rate on properties,” albeit recalling that the disappearance of $350 million in transfers to municipalities begins on July 1, when the fiscal year begins, promising it will be done progressively, so that in the next budget (2017-2018) $175 million disappear, and the remaining $175 million, the next fiscal year, describing it as a “two-year fade out.” Unsurprisingly, he did not specify when or how the plan would fiscally benefit this island’s municipalities, stating: “We have already been able to have pilot efforts to identify different municipalities where 60% of their properties are not being assessed…We are going to commit ourselves so that all these properties are in the system.”

The End of a Chapter 9 Era? Municipal bankruptcy is a rarity: even notwithstanding the Great Recession which produced a significant number of corporate bankruptcies—and federal bailouts to large for-profit corporations and quasi-federal corporations, such as Fannie Mae; the federal government offered no bailouts to cities or counties. Yet from one of the nation’s smallest cities, Central Falls, to major, iconic cities such as Detroit and Jefferson County, the nation experienced a just-ended spate, before—with San Bernardino’s exit last month, the likely closure of an era—even as we await some resolution of the request by East Cleveland to file for chapter 9 municipal bankruptcy. The lessons learned, compiled by the nation’s leading light of municipal bankruptcy, therefore bear consideration. Jim Spiotto, with whom I had the honor and good fortune over nearly a decade of effort leading to former President Reagan’s signing into law of the municipal bankruptcy amendments of 1988, offers us a critical guide of ten lessons learned:

  1. Do not defer funding of essential services and infrastructure: Detroit is a wake- up call for others that there is never a good reason to defer funding of essential services and infrastructure at an acceptable level. If you do, Detroit’s fate will be yours.
  2. Labor and pension contracts under state constitutional and statutory provisions should not be interpreted as a mutual suicide pact: It appears one of the reasons why resolution of pension and labor costs was not achieved in Detroit prior to filing Chapter 9 was the belief of the workers and retirees that, under the Michigan constitution, those contractual rights could not be impaired or diminished to any degree. This position failed to take into consideration that the municipality can only pay that which it has revenues to pay and, in an eroding declining financial situation, there will never be sufficient funds to pay all obligations, especially those that may be unaffordable and unsustainable.
  3. Don’t question that which should be beyond questioning and is needed for the long-term financial survival of the municipality: A dedicated source of payment, statutory lien or special revenues established under state law must be honored and should not be contested. Capital markets work effectively when credibility and predictability of outcome are clear and unquestioned. Current effort to pass new legislation (California SB222 and Michigan HB5650) to grant statutory first lien on dedicated revenues. Further, as noted in the Senate Report for the 1988 Amendments to the Bankruptcy Code and Chapter 9 “Section 904 [of Chapter 9 limiting the jurisdiction and power of the Bankruptcy Court] and the tenth amendment prohibits the interpretation that pledges of revenues granted pursuant to state statutory or constitutional provisions to bondholders can be terminated by filing a Chapter 9 proceeding”. This follows the precedent from the 1975 financial distress of New York City and the State of New York’s highest court ruling the state imposed moratorium was unconstitutional given the constitutional mandate to pay available revenues to the general obligation bondholders. See Flushing Nat. Bank et. al. v. Mun. Assistance Corp. of New York, 40 N.Y.S.2nd 731, 737-738 (N.Y. 1976). Just as statutory liens and special revenues, there is a strong argument that state statutory and constitutional mandated payments (mandated set asides, priorities, appropriations and dedicated tax revenue payments) should not and cannot be impaired, limited, modified or delayed by a Chapter 9 proceeding given the rulings of the Supreme Court in the Ashton and Bekins cases and the prohibitions of Sections 903 and 904 of Chapter 9 of the Bankruptcy Code.
  4. Debt adjustment is a process, but a recovery plan is a solution: As noted above, while Detroit has proceeded with debt adjustment which provides some additional runway so it can take takeoff in a recovery, such plan is not the cure for the systemic problem. Rather, the plan provides additional breathing room so that the municipality, through its Mayor and its elected officials, may proceed with a recovery plan, reinvest in Detroit, stimulate the economy, create new jobs, clear and develop blighted areas and raise the level of services and infrastructure to that which is acceptable and attract new business and new citizens.
  5. Successful plans of debt adjustment have one common feature: virtually all significant issues have been settled and resolved with major creditors: While the Detroit Plan started with sound and fury between the emergency manager and creditors and what they would receive, in the end, similar to what occurred in Vallejo, Jefferson County and even in Stockton (with one exception), major creditors ultimately reached agreement and supported the Plan of Debt Adjustment that allowed the municipality to move forward, confirm the Plan and begin its journey to recovery.
  6. One size does not fit all: There are many ways to draft a plan of debt adjustment and sometimes the more creative, the better. As noted above, traditionally major cities of size with significant debt did not file Chapter 9. They refinanced their debt with the backing of the state which reduced their future borrowing costs and allowed them to recover by having the liquidity and the reduced costs necessary to deal with their financial difficulties. Detroit chose a different path.
  7. A recovery plan must provide for essential services and infrastructure: “Best interest of creditors” and “feasibility” can only mean an appropriate reinvestment in the municipality through a recovery plan where there is funding of essential services and infrastructure at an acceptable level to stimulate the municipality’s economy to attract new employers and taxpayers thereby increasing tax revenues and addressing the systemic problem. While no plan of debt adjustment is perfect or assured, there should be, as the Bankruptcy Court in Detroit throughout the case pointed out, a plan to show the survivability and future success of the City.
  8. Confirmation of a plan of debt adjustment is only the beginning of the journey to financial recovery, not the end: It is important to recognize, as noted above, that Chapter 9 is a process, not a solution. The recovery plan, which will take dedication and effort by the elected officials of the City along with residents, public workers and other creditors is the only way to achieve success. It is measured not by months, but by years, and by the constant vigilance to ensure that the systemic problem is addressed effectively in a permanent fix.